A Self Directed IRA gives you more flexibility, but requires more work


A self directed IRA (also called a "Real Estate IRA") is one type of option for your defined-benefit retirement account.

This account type can provide a retirement investor (i.e. you) with a greater number of investment choices compared to other types of IRAs.

It is NOT simply a retirement account you manage yourself.

There is actually a section of the tax code with specific criteria (Section 408) you need to follow, even though you won't find the terms "self" or "directed" in the text.

It is a great choice for those of you who are not comfortable with the volatility of the stock market and want more control over your money.


What is a Self Directed IRA?


A self directed IRA (or Self-Directed Individual Retirement Account) is an IRA that requires a qualified trustee or custodian to make investments for you on behalf of the retirement plan.

In the tax code that defines IRA's, the government has spelled out who can serve as a "custodian" for a retirement account.

But this definition can be misleading. How can something be self-directed if a "custodian" or "trustee" is making investing decisions for you?

The trustee or custodian acts as your investment broker. They handle all the assets, transaction records, submit IRS reports as required, create and deliver client statements, help you understand rules and regulations, and take care of administrative duties on your behalf (for the life of the IRA account!).

You still make the decisions. The custodian just makes it happen. This is called an "arm's length" transaction, and is one of the minimum requirements for an IRA to be classified as "self directed".

But before you start investing, you'll need to exercise your increased decision-making capability. There are different types of custodians, each providing a different level of service, and you need to pick one.

IRA advisers

    This type of "custodian" is not really a custodian at all (because custodians cannot give you advice - see disadvantages)!

    An IRA adviser does the work for you, and works well if you are looking for guidance throughout the entire process (finding investments, handling investments, and interacting with self-directed IRA custodians on your behalf, etc.)

Independent IRA administrators

    This custodian is part of a larger IRA company, and handles paperwork and internal dealings within the custodial firm.

    You, as an investor, are still responsible for finding and making investments.

Independent IRA custodians

    Experienced investors will probably opt for this type of custodian. They act as a trustee for the IRA account by handling your money (deposits and withdrawals).

    But you manage all other aspects of investing (including paperwork!).

A self-directed IRA can also be used as your traditional or Roth IRA, because the laws related to these two retirement investment accounts also apply to self-directed IRAs.


Advantages a Self Directed IRA?


Self-directed IRA accounts give you more freedom when it comes to investment instruments and asset classes (e.g. equities, debt instruments, real estate, partnerships, etc.).

The IRS provides rules for the assets that can be held in a self directed IRA, which include the following:

  • Real Estate
  • Options on Real Estate
  • Stocks
  • Debt Instruments (Mortgages, Notes, Tax Liens)
  • Franchises and other small businesses
  • Partnerships
  • Private Equity Investments

The good news is that most self-directed IRA custodians and will give you access to all types of investments permitted by the IRS, including foreign real estate!

As far as contributions go, you make annual contributions to a self directed IRA based on the current year's limits.


Disadvantages of a Self-Directed IRA


There are some downsides to creating a self-directed IRA. For example, even though you have a lot of choices, you can still buy an investment that is prohibited by the rules in Section 408.

Also:

  • All transactions must be arm’s-length transactions
  • A custodian or trustee cannot give you any advice
  • The custodian or trustee will need to be specialized
    • This means that you will deal with someone other than your current bankers, brokers, or financial planner
    • Since a custodian will own everything, you need to trust this person!
  • Setting up and managing a self directed IRA time consuming and complicated
    • You need to plan for:
      • Income and Expenses (proportional to your position sizes)
      • Required Minimum Distributions (Not required until April of the year following your 70th birthday)
  • Some investments are off limits (e.g. collectibles and insurance contracts)


Where to find a Self Directed IRA


If you want to set up a self-directed IRA, there are three general steps to follow.

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WARNING:
You MUST get professional financial investment advice before creating a self directed IRA.


The first action you'll need to take is finding a custodian. As mentioned above, this person must be someone you trust and can offer you the right types of investments.

The second step is to create a planning document with the custodian. Afterward, you will roll over funds from an existing IRA or other "qualified plan" to the new self-directed plan.

Finally, you need to be select your asset classes and level of diversification. You can then instruct the trustee or custodian to buy and sell on your behalf.



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